Ellison may face long PeopleSoft fight

Commentary: DOJ opposition could doom deal

MikeTarsala

SAN FRANCISCO (CBS.MW) -- Oracle CEO Larry Ellison may need to live up to his stubborn reputation and take the Department of Justice head-on if he's still intent on owning PeopleSoft.

PeopleSoft said late Tuesday that antitrust officials have recommended that Justice sue to block Oracle's $9.4 billion hostile bid for PeopleSoft. See full story.

The staff recommendation goes to Hugh Pate, the highest-ranking U.S. antitrust official, ahead of his final decision on the matter in March.

It seems unlikely that Pate would rebut eight months of work by the department. It also seems unlikely that he would ignore 200 depositions by software customers -- many bemoaning how Oracle taking over PeopleSoft could make their business software more expensive.

Should the Justice Department nix Oracle's offer, it'll be up to Ellison to battle antitrust history in pushing onward with his quest for PeopleSoft.

With the exception of Sungard Data Systems'
SDS, -1.27%
bid for disaster-recovery services company Comdisco in 2001, very few technology companies beat the Justice Department in court in the past 10 years. Sungard triumphed over the department and won Comdisco in a bidding war with Hewlett-Packard
HPQ, +1.47%

While it's not completely clear on what grounds the Department of Justice would challenge Oracle's bid, the department staff seems to already have reached many of its key conclusions. The most important is that the department has defined the software market narrowly and has determined where there could be higher software prices as a result of a combination.

Months ago, the department defined the market in question as one for core financial and human-resources systems sold to large and complex organizations -- a market serviced by only three software companies: SAP
SAP, +0.06%
Oracle
ORCL, +0.46%
and PeopleSoft
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That means the department's conclusions on any anticompetitive effects would not be focused specifically on software "suites," or prepackaged software made by all three companies. PeopleSoft had argued that there existed a market for suites shortly after Oracle launched its bid -- leading many to believe suites were also the focus of the probe.

Market definition

Limiting the market definition to core financial and HR for large, complex businesses means that extraneous facts applying to broader markets will be thrown out. The Justice Department will not be focusing on the market for selling any software to mid-size or small businesses, the market for customer-relationship management and supply-chain management software, or anything to do with databases -- Oracle's bread and butter.

An argument that Oracle has pricing power in the database market that it will be able to leverage into business applications software -- similar to arguments that Microsoft's Windows
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monopoly is being tied to other markets -- also is unlikely to appear in the staff's report.

Instead, the department staff appears ready to argue that in a narrowly defined market, a combination of Oracle and PeopleSoft has potential negative effects for pricing, as well as the quality of customer service.

Oracle's market concentration also could play a role, although some sources say that in particular isn't likely to be part of the staff recommendation.

The Justice Department does not release information on staff recommendations. It's up to the companies to get the word out.

A report issued by the Prudential Equity Group this week runs its version of the concentration index the department uses as part of most antitrust reviews. Prudential concluded there's a "high probability" the deal will be challenged.

Sources close to the department staff have said it has looked at the market as strictly as one comprised of new software licenses. Others have said the company is concerned with not only new licenses, but service, support and maintenance for the large number of existing PeopleSoft customers that Oracle could acquire.

Oracle executives would probably be pleased if the department viewed the narrowly defined market as new software systems being installed at large blue-chip companies. New financial and HR software sales among large customers is unimpressive -- arguably less than $100 million a year. Very few large companies are ripping out and replacing their core applications software, and aren't likely to do so any time soon.

Recurring income

But license software sales do not account for the billions in total revenue garnered by SAP, Oracle and PeopleSoft. A far larger chunk comes from sales of software services, maintenance and support to existing customers -- the latter two of which come in like an annuity each month to the software makers, long after a company has initially taken out a license.

As it does in many antitrust reviews, the department has looked at whether new competitors could come into the market, in the event that Oracle started to charge more.

Sources say that the staff report will conclude that the price of new software licenses could be driven higher in the narrowly defined market if there are two competitors, instead of three, and that few new suppliers would fill the gap in core HR and financial software for large customers.

Oracle may have had some success in arguing to the department that the company's market position in selling such software would still be dwarfed by market leader SAP, and there are other companies such as Lawson Software that arguably offer core financials and HR software used by large customers.

But if the department were to look at software maintenance and support for existing PeopleSoft customers, Oracle, like many software companies, could be seen to have a near-monopoly in that area. Some say it would have a huge influx of new customers on which to foist that monopoly if it bought PeopleSoft.

If the department sees the market that way, it will be nearly impossible to argue that a new company could come in to compete in offering maintenance on Oracle and PeopleSoft software.

PeopleSoft also seems to have gained traction in arguing that the market for core financials and HR is much larger than just that of new customers. Existing customers count, too, and the quality of service they receive could be diminished if the bid goes through.

Many facts starting to come out that show how much thought the Justice Department is putting into its probe. It's too early to say exactly how the department will do it, but the antitrust staff recommendation gives an indication that the Justice Department is prepared to challenge Oracle's bid.

Ellison may have to make good on his comment that he'll recommend to his board that Oracle fight the department if he loses.

If that happens, PeopleSoft will be in for a much longer fight than it expected.

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